The Angel Empire Strikes Back – Why pay-to-pitch works

This is a guest post by Chris Padfield, Investment Manager with London Business Angels and London Seed Capital. In it he reacts to our latest post from LondonVC, our VC columnist, who argues against startups attending pay-to-pitch events, which are often run by Angel networks.

There has been a lot of discussion on the web over the last week regarding the business angel network business model and in particular “pay to pitch”. While there are certainly elements of truth in some of these complaints, there is also a lot of misinformation and confusion over our actual role and business model.

Why should you care what I say? My background, while at University and despite an Economics degree and my friends heading off to the City, was as a boot strapped entrepreneur launching and more recently so I know the challenges entrepreneurs face. I now spend the majority of my time as the Investment Manager for London Business Angels but also assist on the £5m venture capital fund London Seed Capital. I share an office with a £30m Enterprise Capital Fund and a £50m Regional Venture Capital Fund (both of whom we have co-invested with). Our parent group has £330m of early stage venture capital (sub £8m) under management, making us one of the largest early stage investors in the UK. I believe these set of experiences have given me a reasonable perspective across the early stage funding landscape.

LondonVC’s implicit argument appears to be that angel networks promise to introduce you to Venture Capital funds. [Editor’s Note: I think most would disagree – the main argument was mainly that VCs don’t usually source dealflow from Angel networks, and not from pay-to-pitch events].

In my experience this is not the case. I know of no angel network (we certainly don’t) that promises to introduce you to venture capitalists although perhaps others do. There is a reason we are called angel networks and not VC networks. Saying that, we regularly co-invest with early stage VCs; I did a quick review and these are some we have co-invested with in the past: Catapult Ventures, Create Ventures, GEIF, IQ Capital, Rainbow Seed Fund, AITUA, Creative Capital Fund, Seraphim Capital, Oxford ECF, South East Growth Fund, Octopus Ventures, NESTA, Bridges Ventures, IP Venture Fund, Esperante Ventures, Nova Capital and The Capital Fund – there are certainly more. It is important to remember that angels are generally investing in companies at stages that large VCs are rarely interested so of course the likes of Index, Balderton, DFJ, Accel are not going to be at angel network events; and if they are – it’s to see what might be coming to them in 12-24 months time. Chris Dixon has a great article on why entrepreneurs should be wary of taking seed money from big VCs ; in fact we get deal flow from some big VCs who like a company but it’s too early for them to invest into.

Moving on from “angel networks promise to introduce you to VCs but don’t” tangent to what I believe is the more pertinent issue, the “pay to pitch” issue as brought up by Jason Calacanis. There are a number of reasons why most Angel Networks charge to pitch as opposed to only taking success fees (which is where the majority of revenue comes from). Firstly though, there is an important distinction between an angel club and angel network. An angel club is one where all the members know each other and they setup the club themselves. They generally share the task of reviewing business plans or often will independently bring companies from their networks to the group. It is inappropriate for angel clubs of groups to charge companies anything. An angel network is a different beast. The members don’t know each other before they join, the network will generally have a professional, pay rolled “gatekeeper” and support staff, operate from an office, have a brand and marketing strategy and actively seek out new investors. They are very different types of organisations with very different cost structures. So, why do angel networks charge to pitch?

1. They provide more than simply a pitch:

We charge £850 (not £1250, as LondonVC wrote) for companies to present to our investor network; but included in this is a significant amount of work. We run a half day and full day training session, a day’s support from a pitching coach, a legal seminar, over a week’s worth of support reworking and editing executive summaries and the powerpoint presentation (and trust me they change an awful lot) and share a significant amount of IP developed over 25 years running the network. The cost of this, let alone the actual event itself costs us more than £850 x 6 companies that present and is a sunk cost.

2. To get the entrepreneur’s commitment

While we can argue on the level a company should pay to pitch; having it zero is very risky for angel networks. When you have 70+ investors all taking an afternoon/evening off to see 6 companies – you have a significant problem if one of the companies decides that something urgent has come up (and as every entrepreneur knows there are a lot of urgent things) and cancels. What if a VC/major client/potential employee says the only time they can meet is the same time you were meant to be presenting to an angel network; not an easy call for an entrepreneur. Having a sunk cost really does ensure entrepreneurs take the process as seriously as the angel network (and the network’s investors) do. I’ve seen a number of angel networks cancel events at the last minute because of problems here; and your angel network will not last long when this happens.

3. We can’t control entrepreneurs

We can put a lot of work into preparing a company for investment (sunk cost) but the deal might not happen for reasons the network manager can’t control. A typical example is an entrepreneur doubling their pre-agreed pre-money valuation. Some companies don’t put as much work into raising money from a network (it’s never easy I’m afraid) or follow up appropriately. We do our best to align both entrepreneurs and investors however we can’t force deals to happen. Can you think of any other professional industry with significant sunk costs that works on success fees only where the facilitator has limited control over the process of any deal which is heavily dependent on personalities?

4. Investors are loathe to pay fees

The obvious solution to the problem is to charge investors high memberships to cover costs. We charge our investors £295/year and are very strict on this. Most angel networks I know struggle to charge this or anything at all. It is unfortunately the case that a precedent has been set in the UK that investors won’t pay more substantial fees – but our experience is they simply don’t. The US is more fortunate in this regards where investors are prepared to pay higher fees – but this is the current reality we are faced with in the UK.

5. Cashflow

Angel networks don’t have the relatively comfortable management fees that venture capitalists do. If a VC does not do any deals for a year their LPs might get annoyed – but the employees are still going to get paid. Angel networks rely for the majority of their income on success fees – but having some guaranteed income (member subs, pitching fees, sponsors) ensures that they can at least function for a while – no angel network can sustain itself without actually doing deals unless it has public support (we don’t). Let’s be clear on this, no one has got rich on running an angel network, most are run as not for profits to comply with FSMA regulation. Being a VC is a significantly more comfortable existence and certainly more lucrative.

Given all the above, I think charging to pitch is appropriate and likely to stay – however there is certainly a lot of scope for the level of charging to be reviewed. Since I have started working at London Business Angels I have been able to bring the fee down from £1,250 to £850. This was largely due to bringing on two more sponsors, UKTI and Speechley Bircham – who join our other long standing supporters: Larks, RBS, NESTA, McDermott Will & Emery and Kingston Smith. Without them, the fees would have to be higher. If we were to find another sponsor – we will use that money to lower the fee because it solves problem #5.

We are also working on a number of other initiatives to make it easier (and less costly) for our entrepreneurs to raise money. We are raising our own mini co-investment EIS fund. My aim is that in a year or two, the pre-committed capital that goes into this fund will solve problem #5 so that we can price at a level that satisfies only reason #2/#3. I agree that we should charge as little to companies as possible.

It’s also worth saying that most angel networks don’t focus solely on web/tech/media and the types of companies talked about on Techcrunch. There are a few high profile web/media investors in the UK (of course they together are not capable of investing the £1bn of angel funding annually) but we also raise money for companies in other industries. Med-tech (medical tech) has been particularly popular this year; our largest £2m investment was into a clean-tech company.

I hope that explains my position on “pay to pitch”. I want to make it clear that, as with every industry, angel networks differ by quality. This is not however objective – I regularly hear from entrepreneurs who disliked one network and then the next day hear from one that had a great success with it; I am sure the situation is the same with us; although I believe the majority of companies (and even the ones that did not raise money) have felt our process was good value I have to accept that it is always going to be disappointing for those that don’t; but we are regularly told by companies that even if they don’t raise money they felt the intense education was worth the cost. All I can say is that we do our best to make deals happen.

I have explained our model in full here – and most networks are similar; however there are certainly other models all with different benefits/costs associated with them. I recently met the two entrepreneurs who have setup who are trying to help young student entrepreneurs raise small amounts of finance and have a really interesting model. New and innovative approaches are great for the industry – so if you think the model is broken – get up and fix it. Jason threatened angel networks by running free events – I truly welcome the challenge – the more people helping enabling this type of investment, the better.